Under the 2009 Offshore Voluntary Disclosure Program (OVDP), the penalty applicable to a voluntary disclosure is 20% of the highest aggregate balance in the foreign account(s). Pursuant to IRS OVDP FAQ #35, IRS “examiners will compare the 20 percent offshore penalty to the total penalties that would otherwise apply to a particular taxpayer. Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes.” Penalties for non-willful failure to file the FBAR are $10,000 per year. Thus, the IRS examiner could compare, on one hand, the 20% OVDP penalty with, on the other hand, the $10,000 per year non-willful penalties (usually $60,000, since the OVDP covered the six tax years between 2003 and 2008). The lower amount would be the measure of penalties, $60,000 or 20% of the aggregate account balance.

This calculation assumes facts that would support a non-willful failure to file the FBARs. If the offshore account was especially large, or if the taxpayer used foreign entities such as trusts, foundations or corporations to hide the true beneficial ownership, or if the taxpayer was aware of but ignored the FBAR requirements, then non-willful penalties would not apply. Instead, the penalties for willful failure to file the FBAR are $100,000 per year.

Under the 2011 Offshore Voluntary Disclosure Initiative (OVDI), the possibility of lower penalties based on non-willful failure to file the FBAR no longer applies. Instead, the presumption is that the taxpayer willfully failed to file the FBAR. Thus, for taxpayers who voluntarily disclose foreign accounts under the 2011 OVDI, the comparison is between $800,000 ($100,000 per year, over the eight rather than the six years at issue in the 2011 OVDI), versus 25% of the aggregate account balance (the 20% penalty from the 2009 OVDP was increased to 25% under the 2011 OVDI).

We expected the 2011 OVDI to impose higher penalties than those under the 2009 OVDP, so the 25% penalty amount is not surprising. However, the new presumption of willfulness does seem to us to be particularly punitive and, in many cases, not supported by the particular facts of the case. Many taxpayers, for instance, inherited accounts established decades ago and were simply unaware of the FBAR requirement applicable to an account that they never even set up. To presume that such a taxpayer willfully disregarded his FBAR obligation is wrong and unfair.

What is also unfair is that the IRS recently set forth a new policy that FAQ #35 no longer applies to taxpayers who voluntarily disclosed their foreign accounts under the 2009 OVDP. This new policy was not publicly announced. It was e-mailed to IRS field examiners by higher-ups within the IRS.

First, we take issue with the IRS changing the terms of the OVDP that have been in place for over two years. Taxpayers who disclosed under the 2009 OVDP did so with an understanding of its terms, including FAQ #35, as well as other guidance issued by the IRS with respect to the 2009 OVDP. We must question whether subsequently, and retroactively, denying such taxpayers the opportunity to benefit from FAQ 35 is a “bait and switch” maneuver that violates basic and fundamental concepts of fairness. Such a policy change is also questionable from a legal standpoint in light of historical precedent which prohibits the IRS from issuing rules and setting policy on a retroactive basis.

Second, given the substantial delays that taxpayers faced – – it was announced that, two years into the OVDP, approximately ten percent of cases have been concluded – – including delays between passing the Criminal Investigations Division and assignment to a civil IRS agent (in some cases this took one year), IRS examiners’ long delays in reviewing documents, application of PFIC methodologies over a year into the OVDP, and re-assignment from IRS agent to IRS agent, we can’t help but note that if the IRS had processed OVDP cases faster, more cases would have been concluded before the 2011 OVDI and taxpayers would have had the benefit of FAQ #35.

The counter argument is that the IRS simply “clarified” FAQ #35, which never explicitly referred to non-willful FBAR penalties, to now refer to willful penalties of $100,000 (rather than non-willful penalties of $10,000) that would “otherwise apply”. Thus, FAQ 35 leads to a comparison between 20% of the highest aggregate balance and $600,000 rather than $60,000. However, it appears to us that “clarified” is simply a way to avoid saying “changed the terms”.

The change in policy does not instill much confidence in taxpayers who are presently considering whether or not to come forward and disclose foreign assets under the OVDI.

We will continue to argue on behalf of our clients, in support of non-willful penalties as the proper measure of penalties, if the facts allow it.